Friday, August 31, 2007

My last post introduced some of the work I'm doing to assess the market's technical strength. One of the interesting features of this research is the ability to break the technical strength measure down by sectors within the S&P, based on the scores from five highly weighted stocks within each sector. Here's how the Technical Strength Index (TSI) breaks down as a function of sector, as of 8/30/07:

One of the consistent themes of my research is that information about individual stock performance is useful in making inferences about movements in the market averages. For example, when an index such as the S&P 500 makes a new high but few of the component stocks register corresponding highs, then it makes sense to question the sustainability of that rise. A move that is based upon a few highly capitalized issues reflects less directional sentiment than a move that impacts the majority of stocks.

The Demand/Supply Index, a proprietary measure which I quote daily in my Twitter comments, reflects this "bottoms-up" philosophy, in which you infer strength about the overall market from an analysis of individual market components. Demand is an index of the number of listed stocks that are trading significantly above their short- and medium-term moving averages. Supply is an index of the number of listed shares trading significantly below their moving averages. Day to day shifts in Supply and Demand tell us if the market is gaining or losing momentum.

For quite a few months, I've tinkered with a measure of institutional momentum and trending that captures the directional movement of a basket of stocks that is representative of the major market averages. It is out of that research that I introduce a new proprietary measure of Technical Strength. This post will explain the rationale behind the indicator; future posts will update readings daily.

We will call a stock "technically strong" if it qualifies as being in an uptrend over short and intermediate-term time periods. We will call the stock "technically neutral" if it is neither in a defined uptrend nor downtrend over the short and intermediate-term periods. The stock will be deemed "technically weak" if it meets criteria for being in a downtrend over both time frames.

I will be tracking technical strength and weakness across the 40 stocks in my S&P 500 sector basket. Recall that this basket consists of five very highly weighted stocks in each of the following S&P 500 sectors: Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Healthcare, Financial, and Technology.

My research spits out two sets of numbers daily:

1) The number of stocks that close technically strong, neutral and weak;2) A numerical index of technical condition that quantifies degree of technical strength or weakness.

The beauty of the arrangement is that, because the stocks in the basket are divided evenly among the eight sectors, we can arrive at technical condition estimates for each of the sectors as well as the S&P 500 Index as a whole.

Most important are shifts in technical condition over time, not just single, one-day readings. For example, when a market has risen and is topping out, we will see deterioration in Technical Strength as some stocks and sectors begin to roll over while others stay strong. A similar dynamic occurs over the course of market bottoming.

It is also my expectation that the Technical Strength data will help us identify strong and weak market sectors, as well as strength and weakness within sectors. For instance, the current data show technical weakness in investment banks such as C and JPM, but strength in such commercial banks as WFC.

So let's get started! As of August 30th, we had 18 stocks qualify as Technically Neutral; 13 as Technically Strong; and 9 as Technically Weak. The Technical Strength Index (TSI) closed at +160. These are relatively neutral readings and reflect what we see in the 20-day new high/new low data for listed stocks: five of the last seven sessions have closed with new highs between 400 and 500 and with new lows between 200 and 300.

That suggests a multiday trading range and opportunities for either a meaningful breakout trade or a reversal toward that range midpoint. I'm watching the Russell 2000 futures (ER2) for one clue as to this emerging move.

Thursday, August 30, 2007

* Finding Strengths Among the Intelligences - I recently posted on the topic of assessing your personal strengths and using these to enhance trading. Finding a market to trade and a trading methodology that draws on your strengths are important elements in finding a trading niche. Here's a different approach to strengths that draws upon the research on multiple intelligences: the questionnaire and scoring are anonymous and free of charge. My top three strengths were logic/math; self (having good sense of self, liking to spend time by myself); and social (learning from others, using social skills and intelligence). Makes sense that I'm a trading psychologist who studies and trades historical patterns! I strongly suspect that many traders do not succeed simply because they fail to find a niche that makes maximum use of their strengths.

We've now had four consecutive days in the stock market in which we have closed very near either the day's high price or the day's low. Even more surprising, all four days have seen either up volume or down volume as 75% of the day's total volume. What that means is that traders are trading in a herd. They're either jumping on the long side or the short side.

How unusual is such herd trading? Well, I went back to March, 1965: a total of 10,676 market days. Over that span, we've only had 17 occasions in which four consecutive days in have displayed either up volume or down volume equal to 75% of the day's total.

Following these 17 occasions, the S&P 500 cash index was higher 12 times, lower 5 after 20 trading days. The average gain was 3.20%, much larger than the average 20-day gain of .62% for the remainder of the sample.

Note also that many of these periods represented good buying opportunities in the market for at least the intermediate term.

But maybe it's not the directional bias that's the most important finding here. Observe the distribution of herd periods over the 1965 - 2007 period. Two occurred in the 1960s, none in the 1970s, two in the 1980s, one in the 1990s, and six since 2000!

In other words, we're seeing more herd like movement on the day time frame in this decade than in any prior recent decade. I attribute this to the concentration of funds in large institutions and the increasing involvement of those institutions in high frequency, algorithmic/program trading. If that's true, we can expect--especially in times of uncertainty--increasing trending and volatile behavior during the market day, as large traders either run for the exits or enter the markets simultaneously.

Wednesday, August 29, 2007

Here we see the i-Shares Hong Kong ETF (EWH) and that market's rise to all-time highs, even as world markets have experienced liquidity-related setbacks.

Note the ramping up of volume as price has moved higher. We know that volume and volatility are closely correlated. When we have a parabolic market rise, we see market volatility expanding in the direction of market trend. New high prices are attracting further interest, and that keeps the rally going.

These parabolic rises tend to end badly, as we saw in Japan in 1980 and in the tech stocks in 2000. For now, however, you have to be impressed by a rally that hasn't been derailed by credit concerns, weakness in the U.S. and Europe, and worldwide risk aversion.

Pondering this piece of wisdom from Despair.com, I began to contemplate:

* Websites, seminar providers, and software developers who tout their trading products and services with no objective evidence of their value;

* Brokerage houses that create endlessly inventive ways to make it easier for people to trade, knowing full well that the vast majority will lose their money within a year;

* Management coaches who have never managed businesses; trading coaches who don't trade; life coaches who, to all appearances, are mediocrities in their personal and professional lives;

Good physicians make a referrals if they believe that they cannot provide needed care for a patient. How many vendors of trading products and services would make a referral for people who don't really need their products? How many coaches? How many brokerage houses?

How much self-deception is necessary for such people to justify their life work? How much integrity must they sacrifice to willingly offer such garbage to the public?

And it's not just in the trading world. There are people who justify selling tainted toothpaste to the public and who rationalize the destruction caused by their own pollution. There are those who throw integrity to the winds to support dictators in support of their own self-interests, even as they profess a love of freedom elsewhere. There are leaders who squelch freedom of expression and choice with the deceptive rationale of protecting national security or social order.And how about those smaller, day-to-day compromises? Cheating the diet. Spending the money we should be saving. Mistreating those who depend on us. Taking the easy way out. Perhaps integrity dies the death of a thousand cuts.

I recently heard from a person who worked for a dishonest firm. He knew the business took advantage of customers, but could not change the owner's ways. Now the firm was in legal jeopardy and shutting down. My acquaintance wanted me to provide a reference so that he could get a new job. A reference?? All I wanted was to ask him was how he could willingly suspend his judgment and work for a firm that actively hurt people.

But violations of integrity are everywhere you look:

* You know the family can't pay off the mortgage you're selling them, but you need to make quota.

* You know that the system you're selling is curve-fit, but you can't make money in the markets any other way.

* You know your soldiers have inadequate support, but you send them into battle anyway.

And in those smaller, day-to-day ways, we cheerfully go through life, chip, chip, chipping away at what's left of our integrity. We postpone and procrastinate. We don't make that extra effort. Perhaps worst of all, we live life without outrage, without confrontation.

And then, one day, we open our eyes a bit.

We ask the trading psychologist why it is that we cannot stick to the plans we've made, why we aren't faithful to our own intentions.

What can the psychologist say?

After the habit patterns and psychological toll of a thousand cuts, how could we possibly expect to muster fidelity to purpose?

Trading discipline begins with personal discipline. And personal discipline begins with integrity--and doing the right thing even with the little things.

Tuesday, August 28, 2007

One of the qualities I've noted in highly successful traders is that they don't just follow markets; they also observe themselves. They keep rigorous score: they know how much they make or lose, and they identify what they do right and wrong. In my meetings with them, they don't just look for support. They seek ways to improve themselves and their trading. The very best traders are every bit as hungry to make improvements when they're making money as when they're drawing down.

A second quality I've observed in very successful traders is that they are focused on positive goals, not negative ones. The best traders identify what they want to be doing and turn those ideas into concrete goals for the coming day, week, or month. Lesser traders identify negative goals. They can verbalize what they *don't* want to be doing, but lack a clear vision of what they should be doing to trade well. As a result, they never formulate concrete goals for improvement.

Suppose I reviewed today's trading with you and asked, "What were you working on in today's session? What were your specific trading goals?"

Would you have a clear answer? Were you working on you as a trader, or were you simply working to make money?

The really fine traders turn themselves into objects of study. They never stop improving their trading, refining themselves.

1) Step One: Become A Skilled Self-Observer - Many traders are unable to work on their ability to cope with adversity because they've never stood back and identified what they do to cope with challenges and whether those coping responses are working for them. The self-assessment from the previous post is helpful in breaking coping responses down into eight basic categories. Traders can incorporate these categories into their trading journals and simply observe the steps they have taken each day and week to deal with market challenges. Over time, it will be possible to identify coping patterns that tend to occur during successful trading and those that are associated with unsuccessful trading. The first step toward changing any pattern is becoming aware of that pattern as it is happening. Becoming an observer to your own coping is a first step toward changing the coping.

2) Step Two: Think in Terms of Coping Sequences, Not Individual Behaviors - How we assemble our coping responses into coordinated strategies is more important than the individual coping mechanisms we employ. As a rule, coping strategies that are more complex tend to be more effective than simple strategies that rely upon one or two behaviors. In my work with traders, I will often diagram these sequences as flow charts, showing how coping efforts connect with appraisals, decisions, and emotional consequences. These diagrams help traders become more aware of their own patterned responses to threats. For example, I know that, in my own coping, my first response is usually one of self-control (take deep breaths, tell myself to not overreact), followed by planful problem solving, and positive reappraisal. This coordinated sequence represents how I respond to most challenges, not just ones in the market.

3) Step Three: Become Aware of Deviations From Your Usual Effective Coping - As I stressed in the Psychology of Trading book, alterations in our coping are usually preceded by shifts in our physical, emotional, and cognitive state. These shifts lead us to begin our coping sequences in very different--and usually less effective--ways. For example, when I am coping poorly, I generally follow a sequence of: confrontation/venting, taking responsibility, and avoidance. That is, I will vent my frustrations, blame myself for a bad trade, and then avoid the markets. The change in my coping begins with a shift in my emotional state that leads me to vent rather than engage in self-control. Knowing this shift helps me interrupt the poor coping sequence as soon as I catch myself venting, and I have the opportunity to consciously attempt self-control.

4) Step Four: Mentally Rehearse Effective Coping - Once you're aware of the coping strategies that work for you, you can mentally rehearse (use guided imagery paired with relaxation) challenging market scenarios and walk yourself through the proper sequence of coping behaviors. By vividly imagining how you would like to cope with market adversity, you engage in what psychologist Don Meichenbaum called "stress inoculation": you prepare mind and body for dealing with those challenges in real time. This takes repetition and a willingness to sit with the exercises for more than just a few minutes at a time. The payoff is that, after repeated rehearsal, the good coping sequences become increasingly automatic.

It is not realistic to think that stress can be eliminated from trading. Any field of endeavor that involves decision making under conditions of risk and uncertainty necessarily entails stress. An important key to successful performance is to ensure that the risk and uncertainty never become so overwhelming that they shift you out of the mature coping strategies that you've developed over the years. By becoming aware of what works for you under conditions of threat and systematically rehearsing that, you take an important step toward becoming your own trading coach.

Monday, August 27, 2007

Recently, the gap in yields between 3 month Treasury bills and 3 month commercial paper widened significantly. This is because traders and investors were doubting the ability of corporations to meet their funding needs. The resulting run for the safety of T-bills depressed their yields, creating a gap last week of 1.92%.

To put that into perspective, I went back to 1980 (N = 1444 trading weeks) and found that this was the widest gap during that time. Indeed, the second widest gap was 1.43%, registered during the market panic in October, 1987. The median gap since 1980 has been 1.09%, as commercial paper has traditionally yielded a bit more than Treasury bills to compensate for an additional dollop of risk.

When commercial paper yields much more than Treasuries, however, the market is pricing in far more than a dollop of corporate risk. Since 1980, we have had only nine weekly periods in which commercial paper yields have exceeded those of T-bills by 30% or more. Here are the dates in descending order of yield spread:

20070824

19871030

19871204

19871218

19820924

19871211

19981016

19820917

19821001

You can see that these dates really only represent four periods in recent market history: Fall, 1982; late 1987; October, 1998; and the present period. The first three were excellent long-term buying opportunities. Fading fears of corporate liquidity turned out to be an excellent strategy. Let's see if the recent panic is similarly kind to the bulls.

How do you handle adversity in the markets?My recent post suggested that the effectiveness of your coping methods is important both in moderating the flight or fight effects of stress, but also in helping us retain access to our implicit knowledge of market patterns. Here is a short self-assessment that I've put together to help you identify your coping styles.

Imagine the following situation: You are in a trade and it is gradually moving in your favor. You have a mental stop set and a target price. A program trade hits the market and your position blows through your stop, putting you further in the red that you wanted to be. Rate each of the following reactions to the situation on a 1-5 scale, with 1 indicating that you're not at all likely to respond that way; 3 indicating that you sometimes respond that way; and 5 indicating that you usually or almost always respond that way:

1) I vent my feelings out loud and take immediate action to rectify the situation.

2) I step back from the situation mentally and make sure I'm calm and collected.

3) I tell myself it's not a big deal and that I can get the money back in a later trade.

4) After the trade, I seek support from other traders and from people I'm close to.

5) I hold myself responsible for what happened and take the blame.

6) After the trade, I try to not dwell on what happened and turn my attention elsewhere.

7) I go into problem solving mode and figure out how I can manage the position.

8) After the trade, I review what happened and try to figure out what good might come from the trading experience.

If, like many traders, you respond to this kind of situation in more than one way, write down which response you're most likely to have first, which second, etc.

Think back to a trade situation that you did *not* respond to effectively. Go back to the list and identify which response came first, which came second, etc.

-----

Let's take a look at the results. The eight responses represent the coping strategies assessed by the Ways of Coping Scale developed by Folkman and Lazarus:

3) Self Controlling - Making efforts to keep oneself in control in the situation.

4) Seeking Support - Looking to others for emotional support in the situation.

5) Taking Responsibility - Putting the responsibility for the situation on oneself.

6) Escape/Avoidance - Making efforts to get away from the situation.

7) Planful Problem Solving - Making plans to deal with the situation.

8) Positive Reappraisal - Trying to look at the situation in a positive light.

Remember, none of these coping methods are all good or all bad. All can have their place and all can be overused and misused. The key question is: How do *your* coping efforts work for you?

One easy way to determine that is to examine what I call your "conditional trading outcomes". Take a look at your trading results immediately after you have a meaningful losing trade, a meaningful losing day, or a losing week. Take a look at how well you trade after a position has gone against you. Do you trade better after a drawdown or worse?

How about after you have a few winning trades, days, or weeks in a row? Do you trade better or worse? Breaking down your performance as a function of recent performance will tell you a great deal about how effective you are in coping with risk and reward.

The other excellent indicator of whether your coping is working for you is your emotional experience during trading. If you find that anxiety, overconfidence, frustration, and stress are pushing you into poor decisions, you know that you're not coping well with the uncertainties of markets.

Finally, it is helpful to identify the sequences of coping behaviors that you utilize when you're making good decisions and the sequences when you're trading poorly. Knowing how your individual coping responses come together to form coping strategies can help you cultivate your coping strengths. How to develop those strengths will be the topic for the last post in this series.

Sunday, August 26, 2007

* Followup to Market Strength - My update to the Trading Psychology Weblog offers a chart of the Cumulative NYSE TICK, and you can see the recent surge in buying interest. Indeed, we've had solid daily cumulative TICK readings for six consecutive trading sessions. I went back to July, 2003 (when I first began archiving the data in this fashion; N = 1022 trading days) and found 31 instances in which the five-day average Cumulative TICK was above +500. Ten days later, the S&P 500 Index (SPY) was up by an average of 1.20% (27 up, 4 down). That's quite a bullish edge compared to the average ten-day gain of .37% for the remainder of the sample. Overall, surges in buying have tended to yield further buying interest before reversing.

In my recent posts, I've emphasized that effective coping strategies are essential to those who operate within the financial markets. These strategies are mediated by the appraisals we make of situations and of our own resources. The effectiveness of coping methods is not measured by their ability to eliminate stress; stress is inherent in any activity in which we must make decisions under conditions of risk and uncertainty. Rather, coping is effective if it enables us to make the same sound decisions in the heat of fire that we would make under cool, calm, leisurely conditions.

Improving our coping is important, not just to moderate the impact of stress, but to help us retain access to those subtle cognitive, emotional, and physiological cues that are markers for our implicit knowledge. As I've noted in past posts, we know more than we know we know. What we call intuition is actually an internalization of repeated experience that makes us exquisitely sensitive to patterns in events.

We draw upon such cues continuously when we engage in conversation; those subtle markers tell us when we should respond, when we should acknowledge the speaker, etc. There is no way that any of us could possibly write out all of the rules of social intercourse that we draw upon in any normal conversation; those rules are implicit, rather than explicit. The advantage of implicit processing is that it enables us to respond effectively to rapidly shifting events.

When we do not cope well and are overwhelmed by the mind and body's flight or fight responses, we lose access to those implicit cues. We are more apt to engage in social behavior (interactions with spouses or colleagues) that we will later regret. We become less sensitive to others, distracted by our own turmoil.

Similarly, the trader who is enmeshed in panic, worry, and frustration loses access to subtle market patterns--and especially to the internal cues that are alerts to those patterns. This is how we can make decisions in the heat of market action that we later look back upon and wonder, "How could I have done that? How could I have missed that?"

Coping is crucial, because it keeps us in a zone in which we can reason well explicitly, but can also act swiftly upon our implicit knowing. In my next post, I'll outline specific coping strategies and their strengths and weaknesses, so that you can assess your own ability to handle the challenges of risk and uncertainty and develop ways of strengthening your access to sound coping when those challenges arise.

Saturday, August 25, 2007

If you click on the chart above, you can see the updated count of 10-day new highs minus lows among the 40 stocks that I track in my S&P 500 basket. The 40 stocks are evenly divided among the Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Health Care, Financial, and Technology sectors. They include the most highly weighted stocks within the various S&P 500 sector indexes.

You can see clearly that new highs have consistently expanded during the recent market rally. Interestingly, going back to the start of 2004 (N = 908 trading days) when new highs have exceeded new lows by more than 20 issues (N = 30), the next ten days in SPY have averaged a loss of -.56% (14 up, 16 down). That is considerably weaker than the average 10 day gain in SPY for the remainder of the sample of .32%.

This suggests that, by the time a solid majority of issues are making new short-term highs, the buyers have generally gotten their business done and there has been no bullish edge in the near term.

A reader asked me to comment on Friday's market action, which started a bit weak on low volume and gradually morphed into a rally.

I thought I'd use the occasion to illustrate a broader point that pertains to Friday's trade, but can also be used across various markets and time frames.

In the chart above, we see the 5-minute closes for the ES futures (pink) and a 20-bar Power Measure.

The Power Measure is a moving correlation between the size of a bar (its high-low percentage differential) and the price change of that bar (open to close). The correlation is computed with a moving lookback period, which in this case is 20 five-minute periods, or 100 minutes.

What we're looking for with the Power Measure is what I call trendiness: the relationship between volatility (bar size) and directional price movement. In a trend, we see a correlation (positive or negative) that is becoming more extreme over time and that stays in positive or negative territory for an extended period. In a range bound market, the Power Measure will behave as a kind of overbought/oversold indicator and can be used as an aid in fading range extremes.

A very important relationship: In longer-term bull swings, dips in the Power Measure will occur at successive price highs. In longer-term bear swings, peaks in the Power Measure will occur at successive price lows. An extreme reading in the Power Measure that is not associated with a corresponding new high or low in price is often a great opportunity for a fade. That occurred around Point 200 on the chart, which occurred around 1:00 PM CT on 8/22: we hit a negative extreme to the downside in the Power Measure, but price was holding above the low registered at the prior Power dip.

Early in the day Friday, we looked as though we were topping out in the Power Measure, but notice that the rally on the housing news pushed us right back into positive territory (red arrow). If you look at my Twitter comment at the time, I mentioned that this switched us into a buy-the-dip mode. The reason for that should be clear from the Power Measure: there simply were not enough sellers to sustain a negative relationship between price change and volatility. (We could see that from the absence of very weak NYSE TICK figures as well). To put it in simple terms, the big bars on the chart belonged more to buyers than sellers. That's what makes a trend.

One advantage of the Power Measure is that it can be computed for any time frame and any market in which you have open-high-low-close data. I use it, not so much as a timing tool, as a general reference to tell me whether we are gaining or losing trendiness at various time frames. As the link below explains, I generally am loathe to buy markets that are at high positive readings or to sell markets that are at extreme negative readings unless we're relatively early in a breakout mode. Otherwise, it pays to let the sellers or buyers take their turn and show their inability to move the market to successive fresh lows or highs.

Note: All calculations and charting is within Excel. I don't know of any commercial data services that calculate a Power Measure.

Friday, August 24, 2007

My recent posts have examined stress and coping, two important topics for a field such as trading which--by its very nature--involves decision making under conditions of risk and uncertainty.

I was planning a self-assessment of coping strategies for this post, but decided to postpone that slightly so that I could relay an incident that occurred yesterday.

You may have heard that dramatic thunderstorms and some limited tornado activity hit the Chicago area during the day. Very heavy rains fell through the afternoon as Margie and I moved our daughter Devon into her college dormitory. We heard accounts of 50-70 mph wind gusts in the area.

When we finished the move, we went out for something to eat and heard the air raid sirens sound. This told us we were under a tornado warning. The sky was ominous and the rain very heavy, so we ate leisurely and waited for the storm to pass before returning home.

As we left town, I was struck by a feeling that we shouldn't travel home. Instead, my intuition told me, we should stop for coffee and let the storm pass further east. I had the sense that we would be driving back into the storm. Both of us wanted to get home to our son, Macrae, however. We forged on.

The rain became heavier as we drove. At one point, the sky looked not only darker, but a strange kind of darkness.

That's when a very strong impulse hit me. It's the same feeling I get when a market is trying to go higher or lower and I realize that it can't make it. It's as if my body's telling me: NOW! That's when I place my trade to fade the recent movement. My best trades are accompanied by just such an impulse.

I immediately said to Margie, "We're getting off," and I took the first exit from the highway. We stopped at a restaurant and waited out the storm.

Later I heard of cars that were literally stopped on highways and roads, while others kept going, creating accidents. We also heard of cars that flooded and even floated away on streets that were flooded.

We had made the right decision. We returned home late, but quietly and safely. But I also realized that my initial intuition was right on the money. We *should* have stopped for coffee.

I relate this incident because it is such a dramatic illustration of one of the benefits I find in trading: It is training in decision-making. It teaches us to face life's risks and uncertainties and do the right thing. It also teaches us to hone our perception and to learn to trust it and act upon it without hesitation.

When I sensed risk on the roadway with the change of sky color, unlike many drivers, I had the instinct to fade my initial impulse to get home. That's an instinct born of years of trading. My feeling afterward was the same feeling I get after a good trade: the pride a ship captain must get after weathering a storm--or after being wise enough to avoid one.

Keeping your head and making good decisions in the midst of storms, in life and in markets: that's the training that trading can provide.

Thursday, August 23, 2007

1) The Role of Appraisal - Our stress (flight/fight) responses to life challenges are mediated by our appraisals of situations. It's how we think about situations that contributes to their stressfulness. I recently spoke with traders about perfectionism. A trader up for the week can make seven winning trades and three losing ones and still feel stressed out if he or she focuses on the losers. Conversely, traders can draw down but not be threatened by that, knowing that they have come back from similar setbacks. Stress, therefore, is a function of person/environment relationship: the interaction of situations and how we think about those situations.

2) Primary Appraisal - Our primary appraisals are ones in which we evaluate the danger of events: their threat value for us. This includes psychological as well as physical threat. For instance, one trader trading his own money might lose 3% on a trade and not worry at all: he has 97% of his capital remaining. Another trader might be working at a firm with tight risk guidelines and might fear being fired for such a bad trade. Many times, stress is mediated by primary appraisals that reflect the personal meanings of events for us. A trader might look to trading as a source of independence in life; not having to work for others. Losses may, therefore, be especially threatening, because they are perceived as a threat to that emotional life goal.

3) Secondary Appraisal - Our secondary appraisals reflect our assessment of our ability to handle challenging situations. We are more apt to respond with stress and distress when we perceive that we do not have the resources needed to meet our physical and emotional needs. Experienced traders who have weathered a number of drawdowns make the secondary appraisal that this is a normal occurrence and that they have the tools to effectively handle the situation. Newer traders may lack this experience and doubt that they can come back. This will make even relatively small losses feel quite threatening. Our stress responses thus reflect, not only evaluations of environmental threats, but assessments of our own abilities to deal with these.

Now here's an important idea: When we employ a coping strategy, we're coping not just with a situation, but with our primary and secondary appraisals of that situation. How we think about situations, in life and in markets, affects how we cope with them. Many times our coping responses are ineffective (i.e., they don't protect us from psychological pain) because our appraisals of situations are distorted.

Markets cannot stress us out unless we appraise them in ways that make them personal threats. Many times, it's our trading practices--our failure to control our trading size, frequency, and risk per trade--that contribute to those threatening appraisals. Other times, it's our unrealistic expectations that yield appraisals of threat.

We cannot control markets, but we can control our trading practices and our expectations. That is an important source of psychological edge in trading.

My next post in this series will outline different coping strategies and what these can tell us about our appraisal processes.

Wednesday, August 22, 2007

My evening talk tonight will include a self-assessment of coping skills and how these relate to trading decisions and trade execution. In an upcoming post, I will be elaborating on this topic and presenting a perspective different from the usual "stress-and-coping" model.

Here's a nice overview of two standardized measures of coping in the psych literature. As the overview notes, research suggests that active coping is more effective overall than avoidant coping. There are also indications that problem-focused coping (dealing directly with problematic situations) may be more effective than emotion-focused coping (venting feelings, seeking support).

In my own work, I focus not only on individual coping strategies that traders might use, but on sequences of strategies and their outcomes. It is common for traders to blend several strategies into an ongoing coping process. The key is determining whether or not that process is aiding decision making and performance.

Where high levels of emotional arousal become problematic is when they shift traders out of their usual, effective coping patterns. Freud referred to this as regression: in times of duress, we revert to earlier--and often less effective--modes of coping.

This is why mental rehearsals of effective coping, performed while imagining stressful situations, can be especially effective. The technique helps us access our mature, effective coping even during times of turmoil and uncertainty.

The key is figuring out the patterns and sequences of coping that work best for you so that you can incorporate those into the rehearsals. My next post will help you figure out what works and doesn't work for you, so that you can take steps toward being your own trading coach!

* Money Flows in Troubled Sectors - Home builders haven't meaningfully participated in the post Fed-announcement bounce. LEN and TOL, for example, closed at lows for this bear move. Money flow has been negative 5 of the last 7 sessions in LEN; solid outflows 2 of the last 3 sessions in HD. Financial stocks are off their lows, but money flow has been tepid. GS has seen positive flows 3 of the last four sessions, but net outflows over that same time. LEH has experienced outflows 3 of the last four sessions. An exception: solid inflows at MER for the last four trading sessions.

* Money Flows From Stronger Sectors - Technology not so impressive. IBM, INTC, and MSFT have seen outflows six of the last eight sessions; Staples stronger: KO and PG have seen inflows two of the last three sessions, JNJ has been positive for the last three sessions. We've had negative money flows in XOM seven of the last eight trading sessions, but VLO has had inflows three of the last four sessions.

* Less Bearishness - We've had three straight sessions in which equity put volume has been lower than equity call volume, a sign of some trader relief after the Fed announcement. We haven't had such a string of three days since 7/19. Indeed, we've had equity put volume exceed call volume 13 of the last 20 sessions.

* Real Tick and MB Trading Customers - Stock Tickr is conducting a beta test of its link to those platforms, so that traders can automatically keep tabs of their trade metrics and performance without manually entering data. Beta testers get an extended free trial and a discount on future subscriptions. One nice feature of Stock Tickr is the ability to share trade ideas with others in the community and see what's hot.

Tuesday, August 21, 2007

I've been noticing something interesting. Over time, traffic to this blog has grown rather steadily, but a decreasing proportion of the traffic has been coming from other websites. Indeed, my most recent analysis of traffic stats shows that 7.4% of visitors come here from my personal site. Another 4.3% come to the site from a Google search. I get .7% of visitors from my Twitter page and less than half a percent from any other source.

What this suggests is that, when the traffic numbers vary from day to day, it probably has little to do with other sites linking to mine. As much as I appreciate those links, by and large they account for a small proportion of the people coming to the site. Instead, what I'm finding is that market conditions seem to account for much of the daily variation in traffic. That raises the possibility that blog traffic may itself be a sentiment measure.

Specifically, when the market has been more volatile--especially to the downside--traffic has spiked higher. When the market has been relatively quiet--as it was prior to the recent decline and as it was in today's trade--traffic has been subdued. The traffic to the blog went noticeably lower after the Fed intervention and subsequent rally.

I don't think there's anything special about this blog that would make it a sentiment measure. Rather, I think that, in times of uncertainty, it is human nature (and coping) to seek out information. Because TraderFeed is updated frequently--particularly with the Twitter posts--it is one source that active traders might turn to. It wouldn't surprise me if other frequently updated blogs and websites experienced similar ebbs and flows based on market conditions. I notice, for instance, that Bloomberg's website has experienced a jump in traffic in recent weeks, as measured by the Alexa stats.

I would be interested in hearing from other bloggers and site managers to see if they've noticed something similar. I suspect, for example, that search traffic to such financial sites as Instant Bull might be sensitive to market conditions. Major financial portals might also experience enhanced traffic at times of high market uncertainty.

I'm not sure if there is trade-worthy information in these traffic variations, but it's something I'll be keeping an eye on. If there does seem to be information amidst the traffic noise, I'll be happy to post my real-time observations.

Emotional content is *what* we feel. The balance between positive and negative emotion is a major determinant of emotional content. Research tells us that this balance is greatly influenced by two personality traits: extraversion and neuroticism. People who are high in extraversion--who are sociable and outgoing--report higher levels of positive emotion than those who are low in extraversion. On the other hand, people who are high in neuroticism report higher levels of negative emotion than those low in neuroticism.

Emotional content is important because it affects our processing of information.A large body of research finds that people who are high in neuroticism tend to be self-focused and selectively magnify the negative aspects of situations. Over time, this negative focus can interfere with mood, concentration, and motivation. Individuals who are high in extraversion, on the other hand, have a greater propensity for risk-taking--for better and for worse in the trading world.

To some degree our emotional balance is inherited: if your parents were high in neuroticism, you will have a greater likelihood of displaying the trait yourself. Because extraversion and neuroticism are traits, they tend to be relatively stable across the lifespan. While an introverted, neurotic individual may wish to become the life of the party through self-help techniques or psychotherapy, that outcome is unlikely. More realistic is that people with unfavorable traits can influence how these are expressed.

The ways in which we experience emotion is what is meant by emotional style. A major feature of style is the intensity of our experience. Some people tend to experience feelings very strongly; they have relatively high highs and low lows emotionally. Others are more moderate in their experience: they come across as relatively placid--never very high or low. What we feel and how we feel it interact to contribute to personality. We all know extroverts who are high in intensity--the stereotypic gambler comes to mind--and introverts who are low in intensity: quiet people who keep to themselves.

My experience with traders is that emotional style also interacts with content to affect our trading personalities. Style--the intensity with which we experience--acts as a kind of magnifying glass on emotional experience and thus can also magnify the biasing influences of emotion. The high intensity extrovert is the one most prone to overconfidence and impulsivity; the high intensity person high in neuroticism is most prone to panic and negative thinking.

This is why some of the most standard interventions in trading psychology involve strategies to enhance self-control. Such methods as meditation, biofeedback, and guided imagery help individuals reduce their level of intensity and thus gain control over any extremes of emotional content. In essence, these create emotional thermostats that help a trader modulate his or her experience.

Other interventions in trading psychology--cognitive restructuring work and behavioral methods for treating trauma come immediately to mind--are primarily aimed toward emotional content. By changing how we process information and by reprogramming our emotional responses to stress triggers, we shift ourselves toward a more neutral emotional balance. (The link below on techniques for dealing with emotional disruption of trading details some of these methods).

This is a helpful way of thinking about the kinds of assistance that might benefit a trader. Some traders have a relatively favorable emotional balance (content), but a style that can interfere with objective decision-making. They can benefit from self-control methods. Others have an emotional balance that is out of kilter, which may be magnified by style. They need ways of reprocessing their experience. The techniques used for self-help (or coaching) should be matched to the personality--the emotional composition--of the trader. One size does not fit all.

But what of those gut feelings that can help us make good decisions on the fly? In an upcoming post, I will explore the relationship between emotional style and intuitive decision making: ways of enhancing our access to the positive information underlying some emotional states.

Monday, August 20, 2007

In this post, I will walk through a trade I placed this AM, explaining the rationale for the trade and how it unfolded. This particular trade was one that worked out well; it illustrates many of the ideas I've written about in the blog and in the Twitter comments. In a future post, I will write about a losing trade and what can be learned from that.

If you click on the chart above, you'll see what I was following in a one-minute chart of the ES futures. In this case, I was watching the futures and basing my trade on their action, but the actual execution was in the corresponding ETF (SPY). The trade was to sell the S&P 500 Index at 9:19 AM CT. I bought it back at 9:30 AM CT.

Now the walkthrough:

* Start of the Session - I was anticipating early strength today, given that we saw solid buying interest on Friday. Generally, if we see day-over-day improvements in strength (new highs/lows) and momentum (Demand/Supply), I'll look for spillover strength the next day, such that we'll test the prior day's highs.

* 8:33 AM CT - We opened with positive NYSE TICK and a nice move up, particularly in the ER2 (Russell 2000) futures. My anticipation was a test of the prior day's highs in the Russell. As a result, I was looking for a pullback for a possible entry on the long side.

* 8:36 AM CT - The Yen moves sharply higher and yields on the 10 yr. Treasury move lower. This is more of the risk averse trade that has been associated with falling stock prices--and it's certainly not what the bulls would hope for following a Fed intervention. The Russell futures come off their highs with significant selling; I now entertain the possibility that we will not be able to sustain a move to Friday's highs.

* 8:39 AM CT - When I see that we can't bounce meaningfully from the sharp drop--and especially when I see the Yen move yet higher--I enter my first position of the day, selling SPY. I cover six minutes later for a $.33 profit (about 3 ES points) when the market moves lower, but TICK makes a higher low. This is as close as I come to a "scalp" trade: I'll sell a weak bounce in the TICK and then buy back when the TICK makes its next move into negative territory.

* 8:55 AM CT - My leaning is to the downside, but I'm noticing that TICK is not moving to fresh lows. The market has moved lower after my exit, but I decide not to chase anything. We soon afterward get a bounce back toward the opening highs, with NQ actually touching highs for the session. My idea is to wait for the bounce to run out of steam and re-enter on the sell side.

* 9:08 AM CT - We get a solid upmove in the TICK above +1000, and this pushes us toward those AM highs. I'm watching the financial stocks, such as C, however, and not seeing much strength whatsoever. I'm also seeing that yields remain weak, indicating that there is still risk aversion out there. Despite the seeming strength in TICK, my thought at the time is that market conditions are not right to sustain this strength. Still, I'm not going to sell a market that's making fresh short-term highs until I see evidence that the buying is petering out.

* 9:18 AM CT - We get another upthrust in TICK above +900. NQ is flirting with its recent AM highs; ER2 is unable to make new highs; ES makes a marginal high above its 9:08 AM level but remains below its overnight highs. This looks like a false breakout in NQ. Yields remain weak and those financial stocks just can't catch a bid. As soon as I see some selling from the 9:18 peak, I sell the S&P 500 Index. I'm willing to take 2-3 ES points of heat on the position, but will stop out if we get another surge in TICK above +1000. My price target, labeled in the chart above, is a retest of the AM lows.

* 9:22 AM CT - I see some solid selling in C, and know my position is OK. The ES futures sell off and my stop moves to breakeven. That's a standard risk management tool I use once a position initially goes my way.

* 9:25 AM CT - We get a move down to a new AM low in the NYSE TICK, which generally keeps me in a position until I see some evidence of short-term divergences or hit my price target. But the market bounces sharply from that level, not something I expect. What concerns me is that there's some decent bounce in those financial stocks. At this point, I start hunting for an exit. Any sustained strength in the financials will take me out of the trade; the trade is predicated on risk aversion. I'm no longer feeling comfortable in the position.

* 9:30 AM CT - We get another nice downmove in the NYSE TICK, but I exit the position when I don't see the TICK make a fresh AM low. It's a bit above my price target, but I'm also not seeing new AM lows in C, so I decide to take what I've got: $.46 profit in SPY (about 4-1/2 ES points). Just one minute later, the market (and TICK) move lower without me on board. That's pretty typical: I'll catch a piece of a move, not the whole thing. I have a Chicago commitment and have to leave at 10 AM; that's my trading for the day.

Why did the trade work? I read the AM risk aversion theme correctly and had an open mind to switch my mindset from a long bias to short. My read of the yield and financial stocks as a tell was especially helpful. It was also helpful to see that, while NQ had made AM highs, the other indices had not followed. My execution was also good: I sold when TICK was strong; bought it back when TICK showed weakness.

This, as best as I can recreate, is my flow of thinking during the 11-minute trade. It illustrates the large amount of information that is integrated even for a relatively simple, short-term trade. I am following multiple indices and tracking a market theme (risk aversion) across several different markets. I'm also employing a variety of risk management strategies, from a modest position size (I've cut my size ever since the volatility rose significantly) to short-term holding periods and stops that provide a favorable risk/reward profile for the trade.

While there are rules underlying what I'm doing, the decisions are discretionary. I cannot say that the trade was easy or emotionless. I was very uncomfortable in the last few minutes of the trade when I sensed reduced selling interest in the financial stocks. This no doubt played a role in my exiting the position before actually hitting my price target. Just because the trader is a psychologist doesn't mean he's not affected by psychology!

Questions Following a Fed Move: As we can see from the charts from the excellent Barchart site, gold has been in a trading range since late 2005. Meanwhile, the dollar has trended lower and interest rates are falling on anticipation of Fed cuts and a change in Fed policy away from inflation fighting and toward support of the economy.

Will we see a steepening of the yield curve, as the short end reflects Fed ease and the long end anticipates inflationary pressures? If so, how would that affect gold? How would that affect the prospects for a housing recovery? How would that affect the stock market?

Just wanted to give you an update of the week. I attached my updated spreadsheet in which I have now incorporated all my e mini data for the year. I hit new equity highs again and I'm having a decent month, however this week was extremely tough for me as I think it was for everyone. Even though I have made new p and l highs, I am not too happy with my performance as of late.

That opening spoke volumes to me. Here we've had some of our most volatile and challenging trading of late and he's hitting new equity highs--and he's still looking to work on his game. Instead of becoming overconfident, he's keeping himself focused on the process of trading. That's a quality I've seen time and again, but only among very successful traders.

* Trying to Make a Bottom - On Friday, we had our first positive daily NYSE TICK reading in seven sessions, and it was the strongest reading since the decline began. A chart of the cumulative NYSE TICK is displayed on the Weblog, along with an update of the 20 day new highs/lows and the Cumulative Demand/Supply Index. I will be watching closely this week to see if we can sustain buying interest, as manifested in a positive TICK distribution. When markets bottom from very oversold conditions, we tend to see sustained high TICK readings over multiple days, indicating a broad-based perception among institutions that valuations have become attractive. Friday was a start, but it's the follow through that's key--as we saw after the strong rise (and poor subsequent follow through) on 8/8.

* Who Controls the Stock Market? - In case you've wondered why I make such a big deal out of assessing what the institutions are doing, take a look at the facts of life laid out in stark detail by BZB Trader. Look at how much volume is attributable to the retail trader and how much to program trading (both index arb and other program trade). When you consider the high correlation between volume and volatility, you can see what makes the market move: participation by institutional traders (banks, hedge funds, large locals, mutual funds, etc). Great reality check from BZB; thanks.

* Who is Bullish and Who is Bearish? - Great overview of what smart and dumb money have been doing of late from Trader's Narrative. Note the panicky pulling of money out of the market among fund investors and inflows into bills and bonds. Important tell.

If you click on the chart above, you'll see an annotated chart for Friday's afternoon trade in the Russell 2000 (ER2) futures. For the better part of an hour, we're trading in a range, but the distribution of the NYSE TICK during that range was positive. We then break out of the range on enhanced volume, as buyers lift offers.

The time-trend pattern described in my latest update to the Trader Performance page was triggered when we had 14 out of the last 16 bars closing with higher prices. From that point forward, thrusts in the NYSE TICK above 1000 are no longer able to generate higher prices; there is a stalling out of the rally.

This emboldens the sellers, who proceed to take the market back to the midpoint of the prior trading range. Note that an opposite time-trend pattern occurred as sellers began hitting bids on enhanced volume: 16 of the prior 19 bars had closed lower. Very shortly thereafter, the market bounced higher.

Much of the market's short-term swings consists of counter-movement once markets become too one-sided. When bulls are trapped in positions no longer rising, they become sellers, exaggerating the subsequent decline. When bears are caught in positions no longer falling, they cover shorts, exaggerating the rise.

The key to short-term trading is to be one of the ones trapping the longs and shorts, not to be one of the trapped.

Please rate your current mood on a 1-5 scale by indicating the strength of each of the feelings listed below, where 1 = feeling it very slightly or not at all; 3 = feeling it somewhat; and 5 = feeling it extremely.

As you can see, the odd numbered items represent positive mood; the even items reflect negative mood.

Note that this is not an attempt to assess all moods; nor is it a mental health measure. It's simply a snapshot of how you're feeling at the time.

By tracking your moods during the day and correlating these with your trading performance, you can identify how your own feeling states might be affecting your perception, judgment, and decision-making. This is what I call, in my first book, "taking your emotional temperature". It's a great way to become an observer to your moods, rather than absorbed in them.

Before I launch into the topic of this post, allow me to note that this is the 1000th post to TraderFeed, a number I could have never envisioned when I first started the blog. To put that into perspective, if someone were to post to a site twice a week every week out of the year, it would take almost 10 years to generate a comparable output. Amazing how much work we can do when it doesn't feel like work!

Today's topic is mood. The psychological research, nicely summarized by William Morris in his chapter "The Mood System" in the book Well-Being: The Foundations of Hedonic Psychology, emphasizes that mood is not the same as emotion. Moods are more transient feeling states: a person who has high well-being can experience bad moods, just as depressed people can enjoy occasional good moods. Moods have a surprisingly strong impact upon our functioning, which makes them relevant for performance disciplines such as trading.

The first impact of mood is on memory. When we are in good moods, we tend to form positive memories and inhibit the formation of bad ones. Bad moods, on the other hand, interfere with the creation of good memories, but do not necessarily facilitate negative ones. This has implications for behavior, since our recall may help guide future decisions. In one study cited by Morris, subjects led to feel good rated the performance of their cars and TV sets more highly than subjects not exposed to mood manipulations. This would conceivably impact their future purchasing decisions. Similarly, a trader in a good mood might put a positive spin on his or her performance, leading to an enhanced willingness to assume risk.

Mood also affects our judgment and perception. When presented with positive and negative information, subjects in a good mood will rate the positive news as more informative. Subjects in a negative mood are more likely to rate positive and negative news as equally informative. It's not difficult to see how this could lead traders in positive moods to bias their information processing about stocks and the positions they hold.

In one of my favorite studies, subjects were asked about their satisfaction with life. When asked on rainy, cloudy days, subjects gave more negative ratings than when asked on sunny days. This effect vanished, however, when the experimenter brought the weather to the explicit attention of the subjects. The implication is that subtle factors can affect both mood and perception, but that becoming aware of biases can help us avoid their impact.

Morris' central point is that mood accomplishes a kind of self-regulation, controlling our behavior across a range of situations. When people have negative moods, they tend to focus inward and withdraw from activity. In positive moods, people become more invested in the world around them and more actively engaged. When we perceive that we can adequately meet the demands of the environment, we experience positive mood; when we lack such a perception, the result is negative mood.

"Mood solves a problem for us by providing continuous monitoring of the availability of resources necessary for meeting current demands," Morris emphasizes (p. 181). Mood facilitates action when we perceive that such action will be effectual; it inhibits action when we don't perceive an ability to meet external demands.

In that sense, mood is very different from our more enduring emotional experiences of happiness and satisfaction with life. Mood is a real-time monitoring system for adapting our motivational states to our relationship with our environment. To draw upon an imperfect analogy: emotion is like climate; mood is like temperature.

This has two important implications for traders:

1) Mood Can Have Biasing Effects - Even unnoticed, subtle factors such as the weather can impact perception, judgment, and decision making. This could lead us to be overconfident or underconfident in trading situations. By making efforts to notice our moods and reflect on their sources, we can minimize such bias. In my next post, I will suggest a simple mood checklist that can help traders quickly identify their mood states.

2) Mood Can Provide Information - Moods aren't necessarily something to simply "get over". They are providing us with real time data regarding our ability to meet the challenges of markets. When we experience a bad mood, our minds and bodies are telling us that we're not perceiving that we have the resources needed to make money. Such signals often will occur at points in which market regimes and patterns are changing. This can keep us out of danger, but can also energize us when we see markets fall into line with our research and preparation.

A worthwhile activity for a trading journal is to track P/L (and other trading metrics) as a function of mood during the trading day. I've learned to recognize moods that are pure poison to my own trading and routinely take time away from the screen when those occur. Chief among these is a confused mood. If I feel as though I can't get a handle on what's going on, it's become a great signal for me to stay out of the water until I have a better sense of things. That simple step has saved me considerable money during the recent market turbulence.

Friday, August 17, 2007

The Naperville chapter of the Investors Business Daily group is hosting me for a talk this coming Wednesday evening, August 22nd at the 95th St. library (between Book Rd. and Rt 59). The meeting will run from 5 - 9 PM and will include dinner, educational programming re: their CANSLIM methods, and my keynote talk. The group's registration fee for the event is $35; here is the signup page.

After the event I'll be happy to talk with blog readers re: their trading, markets, trading psychology--you name it! Give me a heads up if you're planning to attend, so I know to look for you. And if you're a student and find the registration fee a bit onerous (it's a standard fee set by the group that covers space, dinner, etc.; I don't charge local groups a speaking fee), send me a note and I'll see what I can do to get you in for my portion of the program. Hope to see you there!

* What's Held Up - We saw some hunting for yield on Thursday; I notice that PEY--the dividend yield ETF--has held above its prior lows and saw nice buying. Those consumer staples have also held up reasonably well as hedges against recession: PG, KO, JNJ. Shares in Japan, on the other hand, are feeling the effects of a resurgent Yen and have shown recent weakness. GS continues as my proxy for concerns about the financial sector; hard to imagine sustaining a reversal in the broad market while those financial stalwarts are making new lows.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.